Strategies for Avoiding (Or At Least Minimizing) Market Discounts

By Betsy Jensen
Ag Commodity Instructor, Northland Community and Technical College

It’s never fun being the bearer of bad news, whether it’s a call over the radio about the telephone pole that jumped in front of the chisel plow, or a letter from FSA informing you that you’ve been randomly selected for an LDP spot check.

I’m sure many elevator managers feel the same way. Since harvest of 2004, they have had to look farmers in the eye and tell them about double-digit discounts for low protein wheat, or a 50-cent discount for low falling numbers. But the elevator managers didn’t invent the discounts; they are just passing the discounts along from their grain buyers. 

I hope discounts become less severe in 2005, but I have no doubt that there will be some sort of discount. Fortunately, there are some things you can do to decrease the severity of discounts.

The first step to avoiding discounts is to not contract with an elevator, and use a commodity broker instead.  You can take advantage of high prices and sell the crop, but you are not obligated to deliver the commodity, and you can shop around for the best price for your quality of wheat. 

You can sell wheat with a broker, and when you find an acceptable cash bid, you sell the wheat at the elevator and buy back your futures position. Bids for low or high protein wheat can vary greatly from one elevator to another, and locking yourself into one elevator eliminates the opportunity to shop around.  When you contract with an elevator, you are also locking yourself into a delivery period, and discounts may be severe during that period. 

The downside of using a broker is margin calls, and I will admit they are not for the faint of heart.  You have to be ready to margin your position, and have the line of credit and lender’s approval to do so.  If you have never used a broker, try to find a happy medium. Maybe contract half your wheat with an elevator, and sell half through the broker. 

Another strategy for avoiding discounts is to use a futures fix contract at your elevator instead of a cash contract.  You can lock in the futures price, but leave the basis open.  It’s similar to selling with a broker, but you are obligated to deliver to a specific elevator during a specific period. 

Here is common scenario from 2004: You sold wheat at the elevator for $3.80 futures, and locked in a 10 under basis, so your final cash price was $3.70. When you delivered your wheat, the futures were still $3.80, but the elevator had an any-protein/any falling numbers bid of $3.10, or a 70 under basis. Discounts for low protein wheat were 10 cents per fifth, and you delivered 12% protein wheat, which means you had a $1 discount for protein. Your $3.70 cash price turned into $2.70, while your neighbor delivered the same wheat for $3.10. 

However, by using a futures fix contract, you are leaving the basis open, so you can tell the elevator manager to lock in the any protein/any falling number basis, instead of the basis for 14%.  You can still forward contract your crop to take advantage of a good futures price, but you’re not obligated to deliver 14% protein wheat, which few farmers harvested in 2004.  The major risk with this contract is that the elevator might not be offering a competitive low quality bid, but that is the trade off for not making margin calls. 

Uncle Sam can also help you out with your low quality wheat, but this is a last resort. Your county loan rate is based on 12% protein wheat, so you can forfeit down to 12% protein wheat, and still receive the loan rate.  Anything below 12% will have discounts, and remember that there are severe low falling number discounts, even at FSA.

You cannot forfeit low falling number wheat without a big discount, and that is a common misconception. I have not personally seen any scenarios where forfeiting wheat has been profitable, but having the loan rate as a security blanket can provide some comfort. A better alternative would be to watch the local elevator for any low quality bid, and when you add an LDP, you almost always beat the forfeit price.  If you have any doubts about the quality, take the loan on the wheat instead of the LDP, because you can’t change your mind once you LDP.

The final suggestion for avoiding discounts is to avoid harvest delivery.  Discounts are the most severe, and premiums are weakest right at harvest, before the quality of the crop is known. No grain buyer wants to pay top dollar for 14% protein wheat if we happen to have a surplus of it. I know harvest delivery cannot always be avoided, but do your best, and try to deliver “neutral” wheat, not low protein, not high, just right in the middle. 

Discounts are here to stay, but that doesn’t mean we throw in the towel and stop marketing our crop. If futures prices are still respectable, there are still opportunities to sell wheat, even if it’s low quality.

Jensen puts her marketing strategies to work farming with husband Brian near Stephen, Minn.  Her market education activities including this column are supported in part by the Minnesota wheat checkoff, directed by the Minnesota Wheat Research and Promotion Council. If you have a question or topic related to marketing that you’d like to see addressed in this feature, call 1-800-242-6118, or email Jensen:

----------------------

Experiment with Grain Marketing Free

Commodity Challenge is an online grain marketing simulation game that gives producers practical experience managing grain marketing price risk with futures, options, and cash sales in a realistic virtual environment, without any real financial risk. Participants can even test their marketing skills against others, with updated standings.

New additions to Commodity Challenge include a marketing plan implementer and the simulation of cash forward contracts.  The addition of the forward cash contract allows producers the opportunity to simulate a typical forward contract of fixing the futures and basis to cover the downside in a bear market. The marketing plan implementer allows producers to identify specific marketing targets at the beginning of the simulation. Those targets then trigger action during the game depending upon market activity. 

Participation is free; all you need is access to the Internet. Go to www.commoditychallenge.com . For more information, contact Chris Labbe, chris@montanamarketmanager.org.